It’s hard for first-time investors to beat the banks

Put simply, there is just one major stumbling block when it comes to thinking about selling bank shares – what on earth do you buy that’s going to do better?

Indeed, try telling “sell" to those investors (and there are plenty of them) who bought their very first share when the
Commonwealth Bank
was floated more than 20 years ago.

Since then the shares have risen 1022 per cent, but that increases to 3960 per cent once those precious dividends are included.

Those first-time investors are known for reinvesting the dividends, so try telling them to sell and see what sort of reaction you get. They are the ultimate “buy and hold" investor. Over the past year or so a different sort of investor has piled into the bank stocks but the common theme is still the dividend.

Term deposits don’t cut it now and investors need income.

But as Clime Investment Management’s director John Abernethy says, contrary to popular belief, bank earnings and dividends do not grow in a straight line.

He thinks rising bond yields should divert the marginal buyer of yield plays and take the froth out of bank share prices.

“In any case three of the big four banks are fully valued, with only a little value in ANZ. Given banks’ cyclicality and leverage, investors should never overpay for bank stocks," he adds.

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That sounds fine, and there’s been a lot of talk about bank stocks in a bubble, but the question is still where to go?

Betting on the dogs

Well, for the brave there’s the “dogs of the Dow" strategy. That’s where investors buy this year’s worst-performing stocks in the Dow Jones (or any other index) in the hope they turn around the following year.

Resources have been on the nose for most of this year as investors fret over China’s growth rate so the contrarian investor would naturally warm to the idea of going for stocks that are unloved.

In addition, this week,
BHP Billiton
’s chief executive
Andrew Mackenzie
said Chinese demand for Australia’s natural resources may prove to be stronger than expected.

But according to Commonwealth Bank equity strategist Tim Rocks, the biggest fall in mining investment is tipped to take place in 2014, with further falls in 2015.

He says mining investment for listed companies is expected to drop 30 per cent between 2013 and 2015 and warns that despite that fall, the consensus revenue forecasts for mining service companies are too high so maybe that sector is still for the brave.

On cue this week WorleyParsons had $1.36 billion wiped off its market value when it said it wouldn’t make a profit target it set just six weeks ago.

Cyclical ambitions

So maybe it’s time to look at stocks that can benefit from a domestic recovery.

In the past investing in shares was more about capital growth. And if the global economy does start to improve then there are some cyclical stocks that could really benefit.

Hopes are high the change of government is going to improve the outlook for consumers and business although the early optimism has been tempered.

For that reason, there are still some large short positions in domestic cyclicals, most notably building materials and discretionary retailers.

But if the bulls out there are right, then names like Boral, CSR, GWA, Bluescope Steel and Downer EDI might take off.

Bell Potter’s Charlie Aitken readily admits that those names read like a list of blasts from the past but he’s a believer that New South Wales is on the verge of recovery and with just a hint of bias says that what’s good for NSW is good for Australia.

“I remain a massive bull on New South Wales and think the state is in for a renaissance over the decade ahead. I have lived in Sydney my entire life and I can tell you that Sydney is getting its swagger back. This is a crucial point with regards to stock selection in Australian equities," he says.

“Strategically, my goal is to find as much direct New South Wales cyclical exposure as I can, or in large caps the least-diluted NSW exposure. In banks that means the two Sydney-based banks in
CBA
and
WBC
[Westpac] who have the greatest proportion of NSW home loans and the greatest NSW banking market share," he adds.

JB Hi-Fi
,
Woolworths
and
Lend Lease
are other stocks he has a leaning to and to show he’s not completely blindsided by loyalty to his home state he recommends avoiding Echo Group.

Growth and risk

Earlier this month Macquarie Equities was encouraging clients to increase their exposure to growth and risk.

Macquarie’s strategist Tanya Branwhite adds that although this cycle will be weak when compared to others, “equity returns, particularly from strong business models, or sectors with above economy average demand, offer investors the prospect of modest but sustained positive returns over the coming years".

The performance of Macquarie Equities’ model portfolio since inception has been 10.7 per cent compared to 8.1 per cent in the top 100 stocks (this includes dividends).

The broker is significantly overweight
Wesfarmers
,
Amcor
,
Brambles
and
CSL
but has positions in
Perpetual
,
Dulux
and
REA Group
.

JPMorgan’s strategist Paul Brunker has three top picks –
ResMed
, Brambles and
Sims Metal Management
– that reflect the broker’s expectations for a weaker Australian dollar as domestic growth fades. Brambles and Sims both offer exposure to any pick-up in growth in the developed world.

Coca-Cola Amatil
is a contrarian pick, based on a view that concerns about structural market change are overdone.